The Bernanke Bust

[Gumby]

Good, good. We are making progress. I think we agree that in a debt-based/credit-based monetary system, the money supply must constantly increase to keep things stable and growing. I don't happen to like it any more than you do.

I don't see MMR as promoting government or promoting the madness of our currency. I see MMR as just describing how it works — flaws and all. Some people use MMR to promote their own ideas. Others just use it to analyze the economy.

where in a debt based/credit based monetary system is the incentive for government to succeed? if an ever increasing supply of money "spent by government" is necessary then it would seem to be incentive to do the opposite, why solve a problem if farting around doing nothing and starting new do nothing programs increases spending and justifies bigger budgets? and being successful and efficient decreases it, why stay out of peoples lives when a nanny-state gives you more opportunity to spend? why be honest when helping out your cronies increases spending and power and being fair doesn't?

seems to me the Borg analogy is scary accurate, unless MMR can be reconciled with limited government ....resistance is futile.....
maybe considering alternative monetary systems is not such a bad idea

Those are excellent questions. Exploring alternatives is a wonderful idea. Let's start a new thread and explore it. In the meantime, MMR shows how our system currently works. Don't shoot the messenger. The fact that MMR exposes those problems is not a flaw of MMR.

But, understand that our country was basically founded as a plutocracy. The entire economic ecosystem was designed and refined so that the wealthy become more and more powerful over time and are in control of the masses — enslaving them with debt. It's not something that can be fought very easily. The powers that be like it the way it is.

[Pointedstick]

Those are excellent questions. Exploring alternatives is a wonderful idea. Let's start a new thread and explore it. In the meantime, MMR shows how our system currently works. Don't shoot the messenger. The fact that MMR exposes those problems is not a flaw of MMR.

Agreed! I'll start the thread on Starbucks points

But, understand that our country was basically founded as a plutocracy. The entire economic ecosystem was designed and refined so that the wealthy become more and more powerful over time and are in control of the masses — enslaving them with debt. It's not something that can be fought very easily. The powers that be like it the way it is.

Also agreed, but this is much more controversial, and hence much more interesting. Sounds like the beginning of a great new thread!

[MachineGhost]

Me too. But, I also have a hard time understanding how one would expect the private sector to thrive — on its own — when a currency issuer doesn't constantly spend enough currency into existence. I'm not saying it can't be done, but my sense is that it would require either ending or limiting interest payments on private credit (which tends to require a growing money supply to pay the interest payments)... or issuing a citizens dividend so that individuals could spend money on whatever they see fit. Otherwise the private sector would typically need to rely on private credit to expand, and that would become unstable and there wouldn't be enough money to pay off the interest on private credit.

Does the Treasury only send out the money to the public that Congress spent into existence in the form of transfer payments?  How else does the spent money get out into the economy unencumbered to be useful in paying back private loans with interest?

[MachineGhost]

i hope some of the MMR fans can answer my question about how a limited government and the system we have as described by MMR can coexist, as i have said i have trouble picturing it myself.

I suspect it is an oxymoron.  If the difference between the government being a currency issuer and private enterprise being a currency issuer is that institutionalized coercion is suboptimal vs voluntary exchange, then in the end we'll wind up back in the same position, just with a different party.  The only way to break out of this paradigm is to end fiat money once and for all.

[MachineGhost]

Pointedstick, that's a fascinating idea — though it would probably be illegal. Even Bitcoin's legality is being challenged. And truthfully, it would be highly unstable since corporations do not last forever. Napster credits practically evaporated overnight. People would much rather put their hard-earned savings into risk-free assets.

So now we're getting down to brass tacks.

Institutionalized coercion is F-O-R-E-V-E-R, or better yet, as Orwell said: “If you want a vision of the future, imagine a boot stamping on a human face –- forever.”?

But a peaceful, voluntary association is but temporary and fleeting!

I think that pretty much sums up the sad, sorry state of the world today.  What's more to argue, really?

[MachineGhost]

...But, personally, I don't see private money creation as the answer. I'd much rather have ultra-safe Treasuries than Starbucks points for my life's savings. You can't safely grow an economy with Starbucks points — it would implode during a credit crunch.

But what happens when the sovereign money itself implodes?  It may last longer than your unnatural life, but some day, all governments will and do fall into total oblivion.  Is MMR proposing "this time is different" and that we've reached a new utopia?

[Gumby]

...But, personally, I don't see private money creation as the answer. I'd much rather have ultra-safe Treasuries than Starbucks points for my life's savings. You can't safely grow an economy with Starbucks points — it would implode during a credit crunch.

But what happens when the sovereign money itself implodes?  It may last longer than your unnatural life, but some day, all governments will and do fall into total oblivion.  Is MMR proposing "this time is different" and that we've reached a new utopia?

Well, likely it's every man for himself, until a new government is formed. Have some of your savings in Gold, just in case (sound familiar)? Let me rephrase. I'd much rather have gold and Treasuries than Starbucks points. Can you imagine Harry Browne recommending people save in Starbucks points??

It's not MMR's fault if a government implodes. Governments implode. MMR doesn't care one way or the other. It just describes how one might keep a fiat monetary system working as long as possible. Of course governments fail. MMR is just a road map on how to keep it going in the right direction if your destination is prosperity. A road map doesn't care if you crash your car — a road map is still just a road map. That's all it is.

[Gumby]

Pointedstick, that's a fascinating idea — though it would probably be illegal. Even Bitcoin's legality is being challenged. And truthfully, it would be highly unstable since corporations do not last forever. Napster credits practically evaporated overnight. People would much rather put their hard-earned savings into risk-free assets.

So now we're getting down to brass tacks.

Institutionalized coercion is F-O-R-E-V-E-R, or better yet, as Orwell said: “If you want a vision of the future, imagine a boot stamping on a human face –- forever.”?

But a peaceful, voluntary association is but temporary and fleeting!

I think that pretty much sums up the sad, sorry state of the world today.  What's more to argue, really?

Not sure what to tell you. This is the system we have. I wish it weren't so.

[hoost]

I still think the final conclusion is that government spending is required, but it could be stated more objectively and not necessarily argue that the system is good or bad.

Hoost, I asked you in my previous comment...

how would you expect the private sector to thrive — on its own — when a currency issuer doesn't constantly spend enough currency into existence. I'm not saying it can't be done, but my sense is that it would require either ending or limiting interest payments on private credit (which tends to require a growing money supply to pay the interest payments)... or issuing a citizens dividend so that individuals could spend money on whatever they see fit. Otherwise the private sector would typically need to rely on private credit to expand, and that would become unstable and there wouldn't be enough money to pay off the interest on private credit

Can you try to answer this? I think MMR comes to the conclusion that government spending is necessary, in our debt-based monetary system, because how else does the government's currency enter the private sector in a growing economy? How else does the private sector grow its savings (which ideally represent a growing pool of goods and services)? How else does the private sector pay down private credit/interest?

Now, perhaps the answer to these questions is that you would just prefer we didn't have a debt-based fiat monetary system that was combined with a fractional-reserve credit-based monetary system. But, if that's you're answer then you need to realize that MMR is not cheering our debt-based fiat monetary system — it's just explaining how it works.

I happen to think that a debt-based fiat monetary system combined with a fractional-reserve credit-based monetary system leads to all sorts of problems and inequalities. I don't like it. But, that's the system we have.

Yes, I did skip over that.  It's an extremely complicated question and I'm not sure I have a good answer to it.  I will say first off that I would prefer we didn't have a fiat monetary system for a number of reasons, but that actually doesn't answer the question.

I think first it might be helpful to look at how things would work if we didn't have a fiat currency and fractional reserve banking.  I believe that we would still have loans being made.  If there were not fractional reserve banking, then the banking system would look a lot different.  If you wanted to deposit money at the bank for safe keeping, redeemable at par on demand, you would probably pay a fee.  A bank in that sense is essentially a secure warehouse.  Banks would not be able to lend this money, because you could show up at any time to reclaim it, and there is no one in the background to create new currency for the bank to give you, so they'd have to hold all of it.  If a bank wanted to make loans, it would have to make sure that the money it was loaning out wasn't a demand deposit.  Banks would either have to use invested capital (raised by selling shares of stock) or time deposits (sort of like a CD).  This would make sure that they can pay out all demand deposits at any time.

In that system, there is no new money being created (this is not necessarily the case, it depends on what is being used as money, but imagine it's true for the sake of the argument).  Loans are made from savings.  In order for someone to pay back a loan they have taken out, the interest payment would have to come out of the profits gained by using the borrowed money.  Interest signifies the amount of money you're willing to pay to have something now, versus later.  Likewise, if I have a lot of extra money sitting around that I'm not using right now, interest is the amount of money I will charge to let someone rent my money for a while.

As a simple example, I think of a logger.  The logger and his partner have a hand saw.  With the hand saw, they can cut down ten trees per day.  There is a new invention on the market called a chainsaw.  It would allow them to cut down 20 trees per day and it costs the equivalent of 20 trees.  The loggers don't have 20 trees worth of capital saved, so they take out a loan.  The loan must be repaid with 22 trees.  Since they can cut down an extra 10 trees per day, they will be able to pay back the loan in 2.2 days (by cutting down an additional 10 trees per day, which the chainsaw permits).  Now obviously the pricing is way off, but the idea stays the same.  The loan and interest are repaid with additional production, which was made possible by utilizing the new capital (chain saw) that was purchased with rented money (the loan plus interest).  

If the chainsaw didn't improve production enough to cover the capital expense of purchasing the chainsaw plus the rate of interest charged by the person with the money, the smart logger wouldn't buy it in the first place.  If the logger had bought it anyway under those circumstances, he would have to reduce his future consumption, and repay the loan out of his existing production, or sell some of his acquired capital to make good on the loan.  Normally, the banker would require some sort of collateral for the loan, so the banker would take over the collateral if the loan wasn't repaid.  Worst case, the banker loses his money and his shareholders' money and has to repay time deposits with shareholders' equity.  Well, worst case he's bankrupt and everyone loses.

This post is already getting lengthy, so I'll start a new one to continue.

[Gumby]

In order for someone to pay back a loan they have taken out, the interest payment would have to come out of the profits gained by using the borrowed money.  Interest signifies the amount of money you're willing to pay to have something now, versus later.  Likewise, if I have a lot of extra money sitting around that I'm not using right now, interest is the amount of money I will charge to let someone rent my money for a while.

As a simple example, I think of a logger.  The logger and his partner have a hand saw.  With the hand saw, they can cut down ten trees per day.  There is a new invention on the market called a chainsaw.  It would allow them to cut down 20 trees per day and it costs the equivalent of 20 trees.  The loggers don't have 20 trees worth of capital saved, so they take out a loan.  The loan must be repaid with 22 trees.  Since they can cut down an extra 10 trees per day, they will be able to pay back the loan in 2.2 days (by cutting down an additional 10 trees per day, which the chainsaw permits).  Now obviously the pricing is way off, but the idea stays the same.  The loan and interest are repaid with additional production, which was made possible by utilizing the new capital (chain saw) that was purchased with rented money (the loan plus interest).

Sorry, but the example of a logger cutting down more trees to pay interest makes no sense when there is a limited supply of trees/money. Eventually the logger would run out of trees to pay its interest payments. To make the interest payments (on a Macro level) typically requires money that does not exist in the private sector to begin with. I say "typically" because the exception to that rule is when the creditor is constantly paying the logger for services while his loan is due. But, in reality, that doesn't happen on a Macro level very often — particularly when the economy slows.

See: http://en.wikipedia.org/wiki/Debt-based_monetary_system (...and then click the link that says "Credit-Based monetary system")

...Since debt and the interest on the debt can only be paid in the same form of money, the total debt (principal plus interest) can never be paid in a debt-based monetary system unless more money is created through the same process. For example: if 100 credits are created and loaned into the economy at 10% per year, at the end of the year 110 credits will be needed to pay the loan and extinguish the debt. However, since the additional 10 credits does not yet exist, it too must be borrowed. This implies that debt must grow exponentially in order for the monetary system to remain solvent.
Source: http://en.wikipedia.org/wiki/Criticism_ ... ve_banking

And reality shows us that this is true. Here are two revealing charts:

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[align=center][/align]

In a debt-based monetary system, public and private debt must grow exponentially in order for the monetary system to remain solvent — particularly if an economy is expected to grow. And this doesn't necessarily result in rampant inflation — as some would have us believe (though it can happen in some situations).

I'm not suggesting exponential debt is a good thing — since it just transfers wealth to those who already have wealth. But, that's how the system stays solvent and grows. If it were up to me, I'd much rather see some issuance of debt-free money (perhaps issued as a citizens dividend, as one option), or interest-free loans from the state governments, or something along those lines. But, we can discuss those ideas in the other hypothetical monetary system thread.

[hoost]

In order for someone to pay back a loan they have taken out, the interest payment would have to come out of the profits gained by using the borrowed money.  Interest signifies the amount of money you're willing to pay to have something now, versus later.  Likewise, if I have a lot of extra money sitting around that I'm not using right now, interest is the amount of money I will charge to let someone rent my money for a while.

As a simple example, I think of a logger.  The logger and his partner have a hand saw.  With the hand saw, they can cut down ten trees per day.  There is a new invention on the market called a chainsaw.  It would allow them to cut down 20 trees per day and it costs the equivalent of 20 trees.  The loggers don't have 20 trees worth of capital saved, so they take out a loan.  The loan must be repaid with 22 trees.  Since they can cut down an extra 10 trees per day, they will be able to pay back the loan in 2.2 days (by cutting down an additional 10 trees per day, which the chainsaw permits).  Now obviously the pricing is way off, but the idea stays the same.  The loan and interest are repaid with additional production, which was made possible by utilizing the new capital (chain saw) that was purchased with rented money (the loan plus interest).

Sorry, but the example of a logger cutting down more trees to pay interest makes no sense when there is a limited supply of money. Eventually the logger would run out of trees to pay its interest payments. To make the interest payments (on a Macro level) typically requires money that does not exist in the private sector to begin with. I say "typically" because the exception to that rule is when the creditor is constantly paying the logger for services while his loan is due. But, in reality, that doesn't happen on a Macro level very often — particularly when the economy slows.

See: http://en.wikipedia.org/wiki/Debt-based_monetary_system (...and then click the link that says "Credit-Based monetary system")

Again, before we can go into how it could possibly work in our current system, we have to think about how interest would be paid if we didn't have a fiat system.  Our current system is a credit-based system (debt-based currency + fractional reserve).  Forget everything you know about the monetary system and macroeconomics and consider the scenario.  In the preceding example we're in la-la land.  That theoretical system doesn't exist anywhere on the planet today that I'm aware of.  The amount of money is fixed and owed to no one.  If banks want to make loans, they have to get the money to loan from someone else; they can't just create new money.  Their balance sheet doesn't grow when they make a loan.  In that case, all loans are created from delayed consumption.

The principle that remains is that the interest and principle must be repaid out of production.  There is no other way to get more money than to produce more goods and exchange those goods for money.  If production wasn't increased as a result of purchasing the chainsaw; if for some reason the chainsaw didn't perform as expected, the logger would have to reduce his consumption and repay the interest out of his existing profits.  This means instead of using the proceeds of his logging operation to buy filet mignon for his family, he buys a loaf of bread and uses the reduced consumption to pay back the loan.

The logger provides the service of cutting down trees.  Other people pay him for that service.  The chainsaw makes the logger more efficient at cutting down trees, allowing him to cut down more trees in the same amount of time.  This additional productivity is what allows the logger to repay the loan plus interest.  In reality, given the fixed supply of money, the increased supply of trees that results from the loggers' improved productivity would tend to drive down the price of trees if demand stayed constant.  The lowest the price would go would be driven by the cost of the chainsaw; if the price of trees went any lower, it wouldn't be economical to purchase a chainsaw.

Also, the logger doesn't pay interest indefinitely.  He pays interest until the loan is repaid.  In the previous example, that would be 3 days.  Once the loan is repaid, the interest payment stops.  Interest is the cost to rent money.  When you're no longer using someone else's money, you stop paying rent.  If the price of trees falls such that it isn't possible for the logger to repay the loan, he will go bankrupt; he may have to reduce his consumption as discussed above.  He may have to look for different work.  The end result is likely that the supply of trees is reduced and the price comes back up to a level at which it's economical to purchase a chainsaw to harvest trees.

[Gumby]

Again, before we can go into how it could possibly work in our current system, we have to think about how interest would be paid if we didn't have a fiat system.  Our current system is a credit-based system (debt-based currency + fractional reserve).  Forget everything you know about the monetary system and macroeconomics and consider the scenario.  In the preceding example we're in la-la land.  That theoretical system doesn't exist anywhere on the planet today that I'm aware of.  The amount of money is fixed and owed to no one.  If banks want to make loans, they have to get the money to loan from someone else; they can't just create new money.  Their balance sheet doesn't grow when they make a loan.  In that case, all loans are created from delayed consumption.

The principle that remains is that the interest and principle must be repaid out of production.  There is no other way to get more money than to produce more goods and exchange those goods for money.  If production wasn't increased as a result of purchasing the chainsaw; if for some reason the chainsaw didn't perform as expected, the logger would have to reduce his consumption and repay the interest out of his existing profits.  This means instead of using the proceeds of his logging operation to buy filet mignon for his family, he buys a loaf of bread and uses the reduced consumption to pay back the loan.

The logger provides the service of cutting down trees.  Other people pay him for that service.  The chainsaw makes the logger more efficient at cutting down trees, allowing him to cut down more trees in the same amount of time.  This additional productivity is what allows the logger to repay the loan plus interest.

Hoost, you've only described what happens on a teeny tiny micro level, but you keep missing the macro picture.

If there are 1,000 loggerbucks in existence, and a lumberjack gets 100 loggerbucks from someone else in the forest, to buy a saw from a saw maker, and now he has to pay back 105 loggerbucks to his neighbor by the end of the month. Where does the lumberjack find those extra 5 loggerbucks from? You say he can produce more goods, and exchange them for 5 loggerbucks to pay the interest. That's all well and good, since there are still 1,000 loggerbucks that exist in the monetary system. But, if 7 lumberjacks in the forest decide to take out loans of 100 loggerbucks each to buy saws, that means that the lumberjacks now owe 735 loggerbucks to their neighbors. Again, you say that these lumberjacks can cut down more trees, but the lumberjacks only have 300 loggerbucks left in their community (and owe 735 loggerbucks to each other) and the saw makers have their 700 loggerbucks now and owe nothing. Money is now very tight for most people in the forest, and people are unwilling to spend. The only way the lumberjacks can keep expanding their businesses and pay back their loans, plus interest, is if the saw makers are spending that money back to into the forest economy. If they don't, the entire model breaks down and the lumberjacks are unable to pay back their interest.

If the saw makers loan the 700 loggerbucks back into the forest economy, then that means that 735 loggerbucks now needs to be paid to the saw makers. So, now the lumberjacks owe 735 loggerbucks to their neighbors and 735 loggerbucks to the saw makers. Suddenly, the forest has a deficit of 1470 loggerbucks. Uh oh...

Even if the saw makers spend money back into the forest economy, there are still 70 extra loggerbucks, beyond the 1400 loggerbucks in principle, that the lumberjacks need to generate through production. The only way the lumberjacks could unwind their loans is if everyone in the forest were constantly paying all of the lumberjacks for their goods and services.

In other words, your example only works in a healthy economy where everyone is constantly spending money to each other before all of the loan payments are due. If anyone decides to cut back, even temporarily, the system breaks down and new money is needed to keep the forest solvent.

In any case, I asked you how we could possibly keep the money supply stable in our current credit-based monetary system (not in la-la land). I don't see how a credit-based monetary system could keep its money supply stable for very long. There's a reason why both private and public debt are constantly increasing in reality.

[hoost]

Hoost, you've only described what happens on a teeny tiny micro level, but you keep missing the macro picture.

If there are 1,000 loggerbucks in existence, and a lumberjack gets 100 loggerbucks from someone else in the forest, to buy a saw from a saw maker, and now he has to pay back 105 loggerbucks to his neighbor by the end of the month. Where does the lumberjack find those extra 5 loggerbucks from? You say he can produce more goods, and exchange them for 5 loggerbucks to pay the interest. That's all well and good, since there are still 1,000 loggerbucks that exist in the monetary system. But, if 7 lumberjacks in the forest decide to take out loans of 100 loggerbucks each to buy saws, that means that the lumberjacks now owe 735 loggerbucks to their neighbors. Again, you say that these lumberjacks can cut down more trees, but the lumberjacks only have 300 loggerbucks left in their community (and owe 735 loggerbucks to each other) and the saw makers have their 700 loggerbucks now and owe nothing. Money is now very tight for most people in the forest, and people are unwilling to spend. The only way the lumberjacks can keep expanding their businesses and pay back their loans, plus interest, is if the saw makers are spending that money back to into the forest economy. If they don't, the entire model breaks down and the lumberjacks are unable to pay back their interest.

If the saw makers loan the 700 loggerbucks back into the forest economy, then that means that 735 loggerbucks now needs to be paid to the saw makers. So, now the lumberjacks owe 735 loggerbucks to their neighbors and 735 loggerbucks to the saw makers. Suddenly, the forest has a deficit of 1470 loggerbucks. Uh oh...

Even if the saw makers spend money back into the forest economy, there are still 70 extra loggerbucks, beyond the 1400 loggerbucks in principle, that the lumberjacks need to generate through production. The only way the lumberjacks could unwind their loans is if everyone in the forest were constantly paying all of the lumberjacks for their goods and services.

In other words, your example only works in a healthy economy where everyone is constantly spending money to each other before all of the loan payments are due. If anyone decides to cut back, even temporarily, the system breaks down and new money is needed to keep the forest solvent.

In any case, I asked you how we could possibly keep the money supply stable in our current credit-based monetary system (not in la-la land). I don't see how a credit-based monetary system could keep its money supply stable for very long. There's a reason why both private and public debt are constantly increasing in reality.

As I said before, I'm not sure I have a good answer so bear with me.  I think that you asked something about how we could pay the interest on credit without expanding the money supply.  There was more to the question, but to me this seems like the most fundamental part.  If we can demonstrate that it's possible to repay interest in a fixed, non-debt based money supply, we can use that logic to make inferences as to what would happen if we did that within a debt based money supply (if it's possible, the money supply would have to shrink; as debt is repaid, money is extinguished. The result would be either deflation or depression; possibly both, but we haven't even determined whether or not it's possible yet so I'd rather stick with that line of reasoning first).

The example of the logger may even be too advanced of an "economy" to analyze.  The problem is that we don't know how many loggers there are, what the supply and demand for logs are, etc.  I think it would be extremely unlikely, if there were only 1000 loggerbucks in the whole economy, and loggerbucks were the general medium of exchange, that chainsaws would cost 100 loggerbucks.  I think it would be even more unlikely that there would be 700 loggerbucks available to be loaned.  In reality, if there were 7 loggers to start with, and chainsaws became available at reasonable prices that made the loggers twice as efficient, at least 2 or 3 of the loggers would probably be driven out of the logging business.

I don't know; maybe we can come up with a simpler example.  I thought the logger example would be simple enough, but as you've demonstrated, it's way to complicated to comprehend.  There are too many unknowns.  The crux of the problem is how interest would be paid back with a fixed money supply.

Hmm.  I'm thinking there might be a way to make sense of it in a 2-person economic system, but my brain hurts now.  I'll do some googling to see if someone has already solved this problem for us; if I can't find anything good, I'll take another stab at it later tonight.    Now I know why I didn't become an economics professor, although it is kind of fun to think about.

[Gumby]

Hoost, I never said that you can't create an example where interest is paid back with a fixed monetary supply. You can. I'll do it for you...

Here is how I can repay 110 credits when only 100 credits exist (and you start out holding all of them), without anyone else or any other money supply being involved:

Step 1: You lend me 100 credits (now I have 100 credits, you have 0 credits, and with interest I owe 110 credits)
Step 2: I buy some widgets from you for 45 credits (now I have 55 credits, you have 45 credits, and I owe 110 credits)
Step 3: I repay 55 credits of my debt to you (now I have 0 credits, you have 100 credits, and I owe 55 credits)
Step 4: I use the widgets to make some gizmos
Step 5: I sell the gizmos to you for 55 credits (now I have 55 credit, you have 45 credits, and I owe 55 credits)
Step 6: I repay the remaining 55 credits (now I have 0 credits, you have 100 credits, and I owe nothing)

Tada!!

But, that's a very simple micro example. And it only works if the economy remains healthy and the creditors are willing to spend money before all loans are due (as I did in the example above). In reality that rarely ever happens enough — and it's even far more challenging when the originally loaned-out money was created out of thin air and needs to be repaid as real money or as additional private credit (i.e. I loan you 1,000 credits when only 100 credits exist). That may sound far fetched, but according to the Fed chart I posted (the second chart, above) Total Credit Market Debt is currently at $54 Trillion, and I can assure you that this number will continue to grow since most of the private sector's "money" is actually just private debt. So, more often than not, private credit snowballs (as we see in the second chart, above) and you need an exponentially expanding money supply (created by issuing public debt) to fill in the gaps that keep appearing (as we see in the first chart, above) — particularly when the economy slows to a crawl and private credit markets seize up.

[hoost]

Okay, that's a nice, simple example that demonstrates that it's possible.  It seems to me that it somehow comes down to labor.  Some of your time working was devoted to repaying me.  And it also seems that the result is that we now have both widgets and gizmos, where we only had widgets before.  That seems pretty reasonable.

Let's run with your example but pretend it's a debt based system.  (This isn't quite what we have, we can go farther with the example)

Step 0: There are no credits.
Step 1: I issue 100 credits as bonds and lend them to you.  (You have 100 credits, I have 0, you owe me 110 credits)
Step 2: You buy widgets from me for 45 credits (You have 55, I have 45, you owe 110)
Step 3: You repay 55 credits of debt to me (You have 0, I have 45, You owe 55)
Step 4: You use the widgets to make gizmos
Step 5: You sell gizmos to me for 45 credits, since that's all I have (You have 45, I have 0, you owe 55)
Step 6: You repay 45 credits of debt to me (You have 0, I have 0, you owe 10)

The problem here is once you repay the debt the credits disappear. The only way for you to pay more credits to me is to borrow more.  Is this what you were getting at?

[Xan]

But in that scenario, you've sold 55 credits worth of gizmos for 45 credits, only because the buyer had only 45 credits.  But that isn't the case; he has 45 physical credits, and he also has the 10 that you owe him.  Wouldn't you sell him 55 credits worth of gizmos for 55 credits, the 45 he has plus the 10 in debt that he can waive?

[Gumby]

Step 1: I issue 100 credits as bonds and lend them to you.  (You have 100 credits, I have 0, you owe me 110 credits)

This wording is a bit confusing. You've issued bonds, which implies that someone gave you money for your bonds, so that you could lend me the money and now you owe someone else an interest payment. But, you said that the other money does not exist. So, maybe avoid mentioning bonds in this example. In a fractional-reserve system, you act like a bank and just extend me a line of credit — which allows me to withdraw from your reserves when needed. I don't mean to nitpick, but I just found that confusing.

Step 3: You repay 55 credits of debt to me (You have 0, I have 45, You owe 55)

You should have 100 credits at this point. I paid you with real currency (the currency is called "credits" in this example). Maybe I should have called them "loggerbucks" or "dollars" or something like that. Sorry about that.

The problem here is once you repay the debt the credits disappear. The only way for you to pay more credits to me is to borrow more.  Is this what you were getting at?

Sort of. When a bank extends you a line of credit (say, access to $100 dollars from their reserve account), and you spend their money into the economy, you owe them $110 in real dollars when all the payments are due. $10 extra dollars are now needed that don't currently exist in the private sector. The only way for you to "make" the extra $10 in time — without additional money being added to the private sector — is if the economy is healthy and money is moving around the private sector fast enough (hopefully between creditors and debtors, as shown in the example).

If you weren't able to raise the money honestly, you would get another line of credit to pay the $110. But, then you'd owe $121 to the second creditor. This is why private credit tends to snowball over time (as we saw in the chart, above). Most of the "money" in the private sector is just revolving credit. Only the government's deficit spending can alleviate this snowballing effect. The real problem is when loans stop getting issued during slowdowns, and you can't generate money quick enough by selling things, and then the government needs to deficit spend to prevent a major default from bringing the house of cards down.

If you haven't noticed, the banking system benefits from both private credit creation and deficit dollars (fattening reserves from both types of interest payments). Banks conjured up this system intentionally — it makes them more and more powerful over time.

[hoost]

Yeah, it is pretty confusing; I'm not sure I have it quite right.  I'm not sure I fully hashed out how it would have to work. 

I was trying to do a debt-based monetary system, but maybe it would be more logical to first do an example of a fractional reserve banking system with a fixed currency.  Yeah, I think that will be better.  Let me take another stab looking at it that way.  Disregard the last one.

To look at fractional reserve, we need to introduce a new concept.  Permacredits, which are fixed in supply and cannot be created or destroyed.  Hoostcredits, which I can issue whenever I want, as long as I hold 5% of the total hoostcredits in Permacredits as a reserve.  Both permacredits and hoostcredits are used as final payments for goods and services.

Step 0: I have 5 permacredits and you have 5 permacredits
Step 1: I lend you 100 hoostcredits (now you have 100 hoostcredits and 5 permacredits, I have 5 permacredits, and with interest you owe 110 credits)
Step 2: You buy some widgets from me for 45 credits (now you have 55 hoostcredits and 5 permacredits, I have 5 permacredits and 45 hoostcredits, and you owe 110 credits)
Step 3: You repay 55 credits of your debt to me (now you have 5 permacredits, I have 5 permacredits and 45 hoostcredits, and you owe 55 credits)
Step 4: You use the widgets to make some gizmos
Step 5: You sell some of the gizmos to me for 52 credits (now you have 7 permacredits and 45 hoostcredits, I have 3 permacredits, and you owe 55 credits)
Step 6: You repay 52 credits (now you have 0 credits, I have 10 permacredits, and you owe 3 credits)
Step 7: I buy the remaining 3 credits of gizmos from you (now you have 3 permacredits, I have 7 permacredits, and you owe 3 credits)
Step 8: You repay 3 credits (now you have 0 credits, I have 10 permacredits, and you owe 0)
Step 9: Hopefully the widgets can be used to make more gizmos, because I have all the permacredits

This got confusing, so I probably mixed something up here, too.  I originally did the example where I started with all the permacredits, but I thought it was more instructive to see how I ended up with all the permacredits in the first place.  Anyway, I'm sure the example can be improved.

[moda0306]

I just had a thought and am putting it here for lack of a better place.

We rightly argue about when and how big deficits should be, and whether they'll be a future hindrance, but one sad thing I've noticed in the case of the U.S. (and probably other countries), is that it seems that if there's a crushing recession, where the government wants to invest in infrastructure and enact stimulus to re-engage individuals in the private sector in productive activity, we have to have a huge debate about it (a good thing, IMO).  There's nothing wrong with this debate, so much as what ENDS the debate (well, probably not on this forum, but in the public in general)... WAR.  The enemy of all things free & productive.  The cause of countless hyperinflations, defaults, mass deaths, horrid acts by otherwise moral men, etc.  This is the one thing people can get behind and decide, THIS, not bridges, trains, and better schools (or tax cuts for the productive), is what's worth going into massive debt for.

If you look at times when our debt has skyrocketed in this country, it's almost always war, many of which were unnecessary (Civil, WWI, WWII (though I think it's arguable we were justified in engaging in WWII), Korea, Vietnam...). 

It'd be one thing if these were "enemy at the gates" type of situations, but they weren't. We were half a world away from most of our enemies most of the time, and in another time one side thought it was worth going to war with their own countrymen to preserve a "Union" that obviously was nothing of the sort. 

[hoost]

I'm with you on that Moda.  It might be a good topic for a fresh thread, although I get the impression that many of the folks on here share this view so maybe it wouldn't take off.  I would also extend it to not just war but also occupation; this is perhaps even more costly.

[Gumby]

Anyway, Hoost. I have no doubt that you can find a situation where principle and interest are repaid in a credit-based monetary system, without any additional money or credit being issued. I'm just saying that it only happens when things are working perfectly and the stars align. The creditors need to be buying goods and services while the debtors are paying their payments in a timely fashion and nobody's businesses are failing. And all of this has to happen very quickly before the payments are all due. But, in reality, creditors aren't constantly stimulating every aspect of the economy, or businesses fail, or money becomes tight, or demand slows, and more often than not, businesses just roll over their credit whenever they need to make a payment.

And within a few decades, Total Credit reaches $54 trillion and looks something like this...

[align=center][/align]

Exponential growth of private credit is to be expected in a "healthy" credit-based monetary system. Again, not suggesting this is a good thing. But, it's just how bankers designed the system to work.

[hoost]

Gumby,

My point there was that the creditors end up with the real assets after the credit dissolves.  If I would've started with 10 permacredits, and you with 0, I think you ended up owing me 10 credits at the end.

So the real question I guess is how does it end and where do the real assets go?  The conclusion I'm coming to is when all the credit dries up the creditors own everything; it seems like the logical end.

What if you substitute private credit for government credit?  How does that change the scenario?  What if we walk through that example with a debt-based currency instead of a fixed currency?  I'm getting tired...too much economics and philosophy for today.  I'll give it a shot tomorrow if you haven't already done so by the time I'm up.

Good discussion; have a good night.

[Gumby]

My point there was that the creditors end up with the real assets after the credit dissolves.

Yes. Exactly. Bankers intentionally designed the system that way.

So the real question I guess is how does it end and where do the real assets go?  The conclusion I'm coming to is when all the credit dries up the creditors own everything; it seems like the logical end.

The government's role is to keep things liquid with new money constantly coming into the private sector. That's my point. If it were not for the government constantly pumping money into the system, the private sector would default on itself (a bit like what you see happening in Europe).

What if you substitute private credit for government credit?  How does that change the scenario?  What if we walk through that example with a debt-based currency instead of a fixed currency?

That's easy. Just look at the charts I posted again (below). Both private credit and public debt tend to increase exponentially. Just like that wikipedia article suggested:

Critics of fractional reserve banking claim that since money creation requires loans from the banking system, people are required to go into debt in order for any new money to be created. They assert that this can debase the means of exchange. Critics find it problematic that banks "create money out of nothing."

One criticism posits that since debt and the interest on the debt can only be paid in the same form of money, the total debt (principal plus interest) can never be paid in a debt-based monetary system unless more money is created through the same process. For example: if 100 credits are created and loaned into the economy at 10% per year, at the end of the year 110 credits will be needed to pay the loan and extinguish the debt. However, since the additional 10 credits does not yet exist, it too must be borrowed. This implies that debt must grow exponentially in order for the monetary system to remain solvent.
Source: http://en.wikipedia.org/wiki/Criticism_ ... ve_banking

(Yes, I realize that it's theoretically possible for the interest and principle to be paid down without new money entering the private sector... but it almost never works out that way, since creditors aren't constantly stimulating the economy behind the scenes to support every debtor).

What saves the private sector from defaulting on itself? Government spending. So, over time, private sector credit grows exponentially and deficit-spending grows exponentially to help keep the private sector solvent. That's what I'm saying. And if you don't believe me, just look at the charts...

[align=center][/align]

[align=center][/align]

Both private credit and the national debt have grown exponentially in our debt-based/credit-based monetary system. And this makes sense, since all money comes from either public debt or private credit. Only government spending can alleviate the private sector's ever-growing credit burden.

These charts are mind boggling to most people. Most Austrians seem to think the private sector can increase savings while the government cuts back spending. But, that's not true in a debt-based/credit-based monetary system. It's just not true. If the government wasn't spending, the Total Credit market would be much, much bigger than the $54 trillion it stands at today. And it would be growing much more quickly.

The $15 trillion in national debt represents $15 trillion in risk-free savings (for both the private sector and the foreign sector).

[hoost]

I'll diverge for a minute before returning to explore a debt-based monetary system in our little 7-step example we have going, because I think that makes it easier to follow.

If you define savings as the total national debt, which you just did, then of course it's impossible for the private sector to increase savings.  The private sector can't add to the national debt.  The question is whether or not this is definition of savings is one worth considering.  Increasing savings as you've defined it doesn't increase wealth; I would argue that in the best case wealth stays the same, it is just redistributed to those who are toward the front of the line to receive the government spending.  If you're measuring everything in dollars, then if you keep adding new dollars the aggregate is going to increase on a dollar basis.  That doesn't mean that we are more wealthy or our standard of living has increased.

If the government wasn't deficit spending, I would argue that the total credit market would have to be reduced, because private credit is leveraged off of government debt; its total amount is limited by capital and reserve requirements.  As government debt began to shrink, the amount of private credit would have to shrink.  We would wind up seeing defaults in the private sector, as there would no longer be new money available to service the existing debt, and we would have a recession.  This is why we hold cash in the PP; it's called a tight money recession because money is literally being destroyed as credit is either repaid or defaulted on.

[moda0306]

Hoost,

MMR has skewered MMT for the point you've just made.  The private sector can save.  It's called investing (not buying Facebook via TD Ameritrade, but dreaming up the website itself and getting a loan & private equity to back you to expand the server, etc... the REAL value created, not the paper behind it... that's what investing means in this context).  If a company on the S&P 500 increases its balance sheet by adding a factory, and taken on a loan to do so, somebody (or more likely many people) owns that loan.  It's likely that this loan has a mortgage on the property... it's almost literally BACKED by the asset itself... kind of like the dollar used to be backed by gold... That is savings.  It's backed by investment (not a promise to pay, but productive asset).  It makes perfect sense that this is the case, because investment is an asset that will provide value into the future, and "savings" is the ability to consume in the future... they MUST match each other to some degree... you can't SAVE unless there's something there to give you when you decide to DISSAVE.

However, relying on investment alone to save is inherantly unstable.  Investment depends on sufficient demand, and demand depends quite heavily on sufficient savings... see how this can lock up?  So if we toss into the mix paper money NOT backed by investment, then we're more able to fully USE the productive capacity of our current base of productive investments, and therefore induce further investment when demand would otherwise be collapsing and therefore so would investment.  So MMR has pointed out to MMT that the private sector CAN save... in fact it's the investment in the private sector that backs all that savings, and the productivity it can induce, that makes our lives so great in the USA... and what gives money a purpose in the first place.